In 2013 Capital Gains Taxes Are Going Up!

The top tax rate on long-term capital gains is currently 15%. That revelation has set off a familiar debate about whether that low rate is appropriate. Often overlooked in these discussions, however, is the fact that the days of the 15% tax rate are numbered.

On January 1, 2013, capital gains taxes are scheduled to go up sharply:

First, the 2001 and 2003 tax cuts are scheduled to expire. If that happens, the regular top rate on capital gains will rise to 20%. In addition, an obscure provision of the tax code, the limitation on itemized deductions, will return in full force. That provision, known as Pease, increases effective tax rates on high-income taxpayers by reducing the value of their itemized deductions. On net, it will add another 1.2 percentage points to the effective capital gains tax rate for high-income taxpayers.

And that’s not all. The health reform legislation enacted in 2010 imposed a new tax on the net investment income of high-income taxpayers, including capital gains. That adds another 3.8 percentage points to the tax rate.

Put it all together, and the top tax rate on capital gains is scheduled to increase from 15% today to 25% on January 1. That’s a big jump. For taxpayers who really believe this will happen, expect a torrent of asset selling in November and December as wealthy taxpayers take final advantage of the lower rate.

Of course, the tax cuts might get extended for all Americans, including high-income taxpayers. That’s what happened in 2010. In that case, the increase in the capital gains rate will be smaller.

Because of the health reform tax, the top capital gains tax rate will increase from 15% to 18.8%. That’s still a notable increase, but would likely set off much less tax-oriented selling this year.